Delta Makes the Big Time


After the market closes on Tuesday, Delta Air Lines will join the S&P 500 index of prominent large-cap stocks. Investors cheered this news, sending Delta stock up more than 9% on Monday.

DAL Chart
DAL Chart

Delta One-Month Price Chart, data by YCharts

This achievement caps a remarkable run for Delta, which was removed from the S&P 500 back in 2005 when it filed for bankruptcy protection. Whereas the company's future was highly uncertain back then, today Delta is well-positioned to stay in the S&P 500 for the long haul. A combination of corporate market share growth, disciplined capital allocation, and competitive costs will help Delta continue growing earnings.

Winning the business customer
The first prong of Delta's strategy has been winning business customers away from its legacy carrier rivals, United Continental and AMR . Delta has been growing aggressively in New York and Los Angeles, two key business markets where it competes head-to-head with both rivals.

In New York, Delta's growth strategy has been particularly successful. After completing a slot-swap with US Airways to enable a capacity increase at LaGuardia Airport, Delta now offers 277 peak-day departures from LaGuardia along with 159 peak-day departures from JFK Airport.

Delta planes on the tarmac at LaGuardia Airport in New York (Photo: Delta Air Lines)

Despite the rapid recent growth, New York has been one of Delta's strongest markets in recent quarters. This is a testament to the success of Delta's strategy there.

Delta is not resting on its laurels, either. Back in June, the company closed on the acquisition of a 49% stake in Virgin Atlantic and initiated a codeshare relationship that is expected to become a full joint venture by next year. This greatly increases Delta's access to London-Heathrow, the top international destination for business travel from New York. This should further boost Delta's corporate revenue share in New York.

Keeping costs down
Growing revenue is critical for Delta's long-term success, but keeping costs in line is equally important. One way that Delta has kept costs down is by economizing on aircraft expenditures. By keeping older planes in service longer, scouring the used aircraft markets for great deals, and opting for older technology aircraft over more expensive state-of-the-art models, Delta has been able to keep a lid on its capital expenditures.

Delta is also implementing a broader $1 billion structural cost reduction program. The company expects to save on maintenance, labor, distribution, and logistics expenses through a variety of business process improvements.

Delta is also restructuring its domestic fleet over the next two years, replacing the vast majority of its 50-seat regional jets with Boeing 717 mainline aircraft and 76-seat regional jets. Both of these larger aircraft types have much lower unit costs than the 50-seat jets, in terms of fuel, maintenance, and labor. This will give Delta a new competitive advantage over United and American, which rely more heavily on 50-seat regional jets.

These cost-reduction initiatives are just beginning to bear fruit. Delta's non-fuel unit costs rose just 2.5% in Q2, which was significantly better than the company's original guidance and the recent trend. Delta's non-fuel unit cost growth is expected to be 0%-2% this quarter. By contrast, United's Q3 non-fuel unit costs are expected to soar by 6.4%-7.4%.

Domination continues
Delta is the best in class among large network carriers. Its focus on improving service in key business markets like New York and Los Angeles is contributing to corporate market share gains. This in turn has helped Delta boost its unit revenues faster than the rest of the industry. Now, the company is poised to eradicate unit cost growth as well.

This has created a winning combination that will keep Delta's profit margins well above peers for the foreseeable future. Delta's readmission to the S&P 500 may be boosting the stock this week, but fundamental improvements at Delta should continue driving gains for investors well beyond this year.

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Adam Levine-Weinberg is short shares of United Continental Holdings. The Motley Fool recommends Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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